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The Most Important Number You Need to Know Before Buying GoPro Inc. Stock

Millions love their GoPro cameras, but does this popular consumer electronics company really need to spend so much on research and development?

Every company has one number that defines its success more than any other. For investors in GoPro(NASDAQ:GPRO), maker of the eponymous and extremely popular action cameras, that number is 14.2%

This is the percentage of GoPro's revenue currently devoted to research and development, and it's perhaps the single largest reason why the company has slipped from strong profitability to a net loss in 2014.

However, my selection of this number comes with a few caveats. GoPro's financial statements are still very much on the thin side, as the company just went public earlier this year and has filed only one quarterly report since. Our understanding of GoPro's financials has also been hurt by the fact that the company's only available quarterly results -- for the first and second quarters of 2013 and 2014 -- record periods that typically show a slowdown in sales following the fourth-quarter spike from its traditional October product launches.

Other metrics, such as GoPro's revenue growth rate or its average revenue per unit, might be more valuable if we had more quarterly data to draw on. But since we can only really compare the first halves of 2013 and 2014, it's difficult to justify selecting these metrics ahead of R&D to revenue, which has grown enormously since 2010 to become nearly as large as the percentage of GoPro's revenue spent on sales and marketing:

Sources: GoPro financial filings. (A) refers to annual results.

The shift in spending is quite remarkable. It tells the story of a company that is becoming more confident in its strong brand to drive sales, while simultaneously becoming less confident in its unique technological edge over a relatively thin field of serious competitors. The size of GoPro's R&D spending relative to its revenue has also grown shockingly large for a straightforward consumer electronics company with a very narrow specialization. For example, here's how GoPro compares to some other consumer electronics manufacturers across various specialties (as well as a couple of huge jack-of-all-trades companies):

Source: Morningstar. * Leapfrog historically spends much more on R&D vs. revenue in the first and second quarters.

None of these companies can serve as a direct comparison to GoPro, but it's incredible to see GoPro, in terms of R&D as a percentage of revenue, outspending two of the world's largest mobile-electronics manufacturers, the maker of the Xbox and Windows Phone, an educational tablet maker, and a company that builds autonomous robots ... to make action cameras!

The only comparisons that come close are those with LeapFrog and iRobot, which are also leaders in niche electronics. LeapFrog is most similar, as it also generates most of its sales during the fourth quarter, but LeapFrog also has a significant software development operation -- without good apps, its tablets would be useless. GoPro, on the other hand, does not strictly need a deep suite of support software -- image- and video-editing apps are all most GoPro camera owners would ever really use.

Software focusWhile GoPro's software development effort helped its R&D spending more than double as a percentage of quarterly revenue over the past year, the company's own apps aren't widely seen as the best apps for its hardware! Start-up BrightSky Labs has received a lot of positive press since September for a video-sharing app that streamlines the video-editing process for GoPro's users, which is something GoPro's native software suite should have focused on to begin with. Livestream, a leader in real-time streaming, has also rolled out a GoPro-friendly app to help its active users share their crazy adventures as they happen. GoPro doesn't do either of these things well, and yet it somehow needed to spend almost $35 million on R&D in the second quarter.

Developing innovative new hardware can be costly, but when you look at the list above, it's striking to see that consumer electronics companies of both massive (Samsung) and modest (iRobot) scale tend to spend less on R&D as a percentage of revenue than GoPro despite needing to overcome larger technical challenges. Samsung not only manufactures smartphones and big TVs, it also makes a wide range of chips and components, which is a notoriously research-intensive business. iRobot regularly develops machines that are supposed to help out around the house without any assistance from you -- autonomous systems are far tougher technical challenges than image capture or video recording, both of which are largely handled by technology GoPro gets from external suppliers.

Foolish thoughtsAs GoPro's third- and fourth-quarter numbers come in, we should get a better picture of the company's spending priorities, and its ability to control costs as sales grow. For the time being, however, GoPro's unusually large amount of R&D spending should be a crucial issue for long-term growth investors, as most of the company's other financial metrics have shown the right sort of momentum.

Author

Alex Planes specializes in the deep analysis of tech, energy, and retail companies, with a particular focus on the ways new or proposed technologies can (and will) shape the future. He is also a dedicated student of financial and business history, often drawing on major events from the past to help readers better understand what's happening today and what might happen tomorrow.